Rand’s record slump may not be over

Even after falling to its weakest level on record against the dollar this week, South Africa’s currency has a better chance of extending the decline in coming months than rallying to stronger levels predicted by analysts in a Bloomberg survey, options pricing suggests.

The local unit lost just over 3% on Friday, breaching R19.00 as the steep selloff of emerging markets continues, noted Bianca Botes, executive director at Peregrine Treasury Solutions.

“The ongoing selloff brought on by the failure in confidence on the back of the Covid-19 fallout leaves countries such as South Africa, with poor fiscal metrics, with nowhere to hide. Fitch moved to downgrade SA further into junk terrain, with a negative outlook.”

Fitch on Friday (3 April), adjusted its assessment of the country from BB+ to BB, with a negative outlook, leaving the rand to flounder against the major currencies.

Dollar/Rand: R19.03 (3.76%)

Pound/Rand: R23.48 (3.09%)

Euro/Rand: R20.58 (3.23%)

“The reasons cited are no surprise and in line with what markets already knew – weak economic growth and a deteriorating fiscal position. The announcement by Fitch, following last week’s announcement by Moody’s, comes as yet another hard blow to the local economy that is already under severe strain,” Botes said.

And prior to Fitch, the rand had been pummeled by the risk sell-off sparked by the spread of the coronavirus, as well as a downgrade to junk by Moody’s Investors Service last week.

“Prior to the corona crisis, our initial strategy had been to wait for the downgrade and then re-consider an overweight,” Christian Wietoska, a London-based strategist at Deutsche Bank AG who sees the rand weakening to R20 per dollar, said in a note to clients.

“But the situation has now changed and we find risk-reward as not attractive enough to get bullish immediately post the downgrade, considering the domestic challenges and the external backdrop.”

The median forecast of economists in a Bloomberg survey puts the rand at 16 per dollar by year-end. But there is less than 30% chance of this, according to Bloomberg’s probability calculator based on prices of options to buy and sell the currency. The probability of the rand hitting 21 this year, however, is 52%.

A depreciation to R21 is possible, said Lars Merklin, a senior strategist at Danske Bank A/S, but it would be an overshoot. Danske’s own forecasts see the currency weakening to R19 per dollar.

The South African Reserve Bank doesn’t target a level for the currency or intervene in the market to support it. It’s been reticent to cut rates, however, citing concerns about the effect of a weakening currency on inflation even as the economy posted recessions in 2018 and 2019.

Even a surprise cut of 100 basis points earlier this month leaves South Africa’s real rate higher than many of its peers.

“There is no long-term driver of growth,” Merklin said. “Both the central bank and investors have for too long thought it was necessary to have a strong currency, rather than support the economy.”

With stagnant growth, low inflation, relatively high rates and growing consensus among investors that those factors will continue to plague South Africa for some time, the trend for the rand is weaker before it recovers – but then only to around R17 per dollar, said Merklin.

“Currencies with weak fundamentals will continue to be hit hard in this environment,” said Hans Gustafson, a strategist at Swedbank in Stockholm.

“South Africa’s growth was weak even before the corona outbreak and government finances are deteriorating fast. Looking at the the real effective exchange rate, the rand has another 10% on the downside.”